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Savings Glut and Secular Stagnation Or Central Bank Policy? Thomas Mayer and Gunther Schnabl*

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Savings Glut and Secular Stagnation Or Central Bank Policy? Thomas Mayer and Gunther Schnabl* THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOLUME 24 | No. 1 | 3–40 | SPRING 2021 WWW.QJAE.ORG Reasons for the Demise of Interest: Savings Glut and Secular Stagnation or Central Bank Policy? Thomas Mayer and Gunther Schnabl* JEL Classification: E12, E14, E32, E43 Abstract: This article compares the Keynesian, neoclassical and Austrian expla- nations for low interest rates and sluggish growth. From a Keynesian and neoclassical perspective, low interest rates are attributed to aging societies, which save more for the future (global savings glut). Low growth is linked to slowing population growth and a declining marginal efficiency of investment as well as to declining fixed capital investment due to digitalization (secular stagnation). In contrast, from the perspective of Austrian business cycle theory, interest rates were decreased step by step by central banks to stimulate growth. This paralyzed investment and lowered growth in the long term. This study shows that the ability of banks to extend credit ex nihilo and the requirement of time to produce capital goods invalidates the permanent IS identity assumed in the Keynesian theory. Furthermore, it is found that there is no empirical evidence for the hypotheses of a global savings glut and secular stagnation. Instead, low growth can be explained by the emergence of quasi “soft budget constraints” as a result of low interest rates, which reduce the incentive for banks and enterprises to strive for efficiency. * Thomas Mayer ([email protected]) is the founding director of the Flossbach von Storch Research Institute, Cologne, Germany. Gunther Schnabl (schabl@wifa. uni-leipzig.de) is a professor of international economics and economic policy in the department of economics at Leipzig University, Germany. Quart J Austrian Econ (2021) 24.1:3–40 https://qjae.scholasticahq.com/ 3 Creative Commons doi: 10.35297/qjae.010085 CC BY 4.0 License 4 Quart J Austrian Econ (2021) 24.1:3–40 INTRODUCTION ince the 1980s, slower economic growth in the industrial Scountries has been accompanied by lower interest rates, with real interest rates turning negative more recently (figure 1). The fight against the economic consequences of the severe corona crisis has triggered an even stronger monetary expansion, with even more government bond yields falling into negative territory. At the same time, investment, productivity growth, and economic growth have continued to slow. Although to some observers the pivotal role of central banks in ever-lower levels of interest is evident, representatives of central banks have stressed structural factors as the reasons for low interest rates (Lane 2019, Schnabel 2020). Figure 1. Nominal and Real Short-Term Interest Rates in the US, Japan, and Germany 14 12 10 Nominal 8 6 Percent 4 2 Real 0 -2 1980 1985 1990 1995 2000 2005 2010 2015 2020 Source: IMF. Arithmetic mean. Real interest rates calculated based on official consumer price inflation statistics with hedonic price measurement. Different schools of thought have provided different theoretical and empirical explanations. Based on Keynes (1936) and Hansen (1939), Bernanke (2005) and Summers (2014) have attributed secularly declining real interest rates to a global savings glut driven by aging societies, a declining demand for fixed capital investment, and a declining marginal efficiency of fixed capital investment (Gordon 2012). Łukasz and Summers (2019) argue that “the neutral Thomas Mayer and Gunther Schnabl: Reasons for the Demise of Interest… 5 real rate for the industrial world has trended downward for the last generation and this is best understood in terms of changes in private sector saving and investment propensities.” According to their view, central banks are simply adjusting to the exogenous forces of secular stagnation when they set the interest rate at or below zero. In contrast, from the point of view of Austrian economic theory in the tradition of Mises (1912) and Hayek (1931), human beings strive to achieve their goals earlier rather than later and thus have a “positive time preference.” This makes negative interest rates under free market conditions impossible (Mises [1949] 1998). This view is in line with the finding of Homer and Sylla (2005) that through most of economic history real interest rates were positive. In this spirit, based on the monetary overinvestment theories of Mises (1912) and Hayek (1931) and in line with Borio and White (2004) and White (2006), Schnabl (2019) has argued that the gradual decline of interest rates in the industrialized countries has been due to asymmetric monetary policies: strong interest rate cuts during crises were not followed by respective increases during the postcrisis recovery. The question of whether the gradual decline of real and nominal interest rates in the industrialized countries (and the rest of the world) is due to structural change, as suggested inter alia by Summers (2014) or due to policy decisions made by central banks is crucial for the economic policy agenda. The Keynesian interpre- tation can be used to justify further interest rate cuts, even below zero,1 as well as fiscal expansion. In contrast, from the Austrian point of view only renouncing policies that have led to low and even negative interest rates can reanimate economic activity. This article compares the two approaches and derives policy implications. THE KEYNESIAN AND NEOCLASSICAL INTERPRETATION OF LOW INTEREST RATES AND GROWTH The close relationship between declining nominal and real interest rates and declining (productivity) growth is in the Keynesian and 1 Agarwal and Kimball (2019) of the International Monetary Fund (IMF) have compiled a guide for central banks on how to enable deep negative interest rates in order to fight recessions. 6 Quart J Austrian Econ (2021) 24.1:3–40 neoclassical view due to exogenous factors. Structural change leads to changes in supply and demand conditions in the capital markets, with the result that the real interest rate declines. In the spirit of Hansen (1939), Bernanke (2005) attributes a savings glut to the aging of societies. As people approach retirement age they are seen to save more for old age. When the cohort of aging people is large, in the Keynesian and neoclassical approach the aggregate supply of loanable funds and equity capital rises. At the same time, profitable investment opportunities are seen to decline, reducing the demand for loanable funds and equity capital (Summers 2014). Savings Glut, Secular Stagnation, and the Keynesian Natural Interest Rate Following the sharp interest rate cuts of the US Federal Reserve in response to the burst of the dot-com bubble at the beginning of the new millennium, Bernanke (2005) attributed an increase in the US current account deficit (i.e., growing net capital inflows to the US) and the decline of world interest rates to factors outside the US: “A global saving glut … helps to explain both the increase in the US current account deficit and the relatively low level of long-term real interest rates in the world today.“ Bernanke (2005) argued that aging populations in a number of industrial countries and several emerging market economies, notably China, had transformed these countries from net borrowing to being net lenders on international capital markets, with the result of increased net capital flows to the US. According to Bernanke (2005), East Asian countries prevented their exchange rates from appreciating and accumulated foreign reserves to boost the competitiveness of their exports and create war chests against balance of payments crises.2 Bernanke (2005) also observed higher US dollar earnings for oil- and raw materials–exporting countries due to rising oil prices, which were to a large extent recycled into US dollar investments. Before the subprime crisis, capital flows to the US were attracted by fast productivity growth, strong property rights, and a robust regulatory environment. 2 In 1997–98, the Asian crisis, which had been caused by large net capital inflows, overinvestment, and current account deficits, put an abrupt end to the economic miracle in a number of Southeast Asian countries (Corsetti et al. 1999). Thomas Mayer and Gunther Schnabl: Reasons for the Demise of Interest… 7 After the outbreak of the subprime crisis, which culminated in the global financial crisis of 2007–08 and prompted the Federal Reserve (and other large central banks) to cut interest rates toward zero, Summers (2014) developed a comprehensive explanation for the global decline of nominal and real interest rates from a capital market perspective. On the supply side of the capital market, Summers (2014) linked low birth rates in industrialized countries to growing savings in the tradition of Hansen (1939)3 and Bernanke (2005), who had argued that people in aging societies would save more for retirement.4 Summers associated growing income inequality with a declining marginal propensity to consume (an increasing propensity to save) in a large part of the population.5 Following Bernanke (2005), he identified accumulation of reserves in emerging market economies as a reason for the increased demand for safe assets available in the US.6 On the demand side of global capital markets, Summers (2014) linked a lower demand for fixed capital investment to changes in tech- nology. He assumed that companies in the information and commu- nication technology sector would have a lower demand for fixed capital. Like Bernanke (2005) and Gordon (2012), Summers (2014) argued that the potential of innovations to increase productivity had 3 In the 1930s, Hansen (1939) had argued that low growth was caused by slowing population growth and limited scope for technological innovation. He had dubbed this phenomenon “secular stagnation.” 4 Keynes (1936) distinguishes eight savings motives from an individual perspective: preference for private profit (i.e., interest), intertemporal substitution motive, life-cycle motive due to decreasing income after retirement, precautionary motive, independence motive, enterprise motive, bequest motive, and avarice motive. The theory of a savings glut in an aging society randomly picks out the life-cycle motive and applies it to the entire society.
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